Obama's Bad Bank Plan Could Destroy His Promising Presidency -- How Do We Push Him in the Right Direction?

By Robert Kuttner, Huffington Post. Posted April 14, 2009.

"Part of the Way with LBJ"  --Students for a Democratic Society button, circa 1964

Progressives now find themselves in an awkward position of simultaneously wishing Barack Obama well, but feeling dismayed by his policies on some key issues, most notably the banking bailout. If this were a normal economic situation, the posture of semi-opposition would not be that big a deal. We would simply gratefully accept the decent policies and keep pressing for bolder ones. But a failure to revive the banking system would be Obama's Vietnam. It would wreck everything else.

It's a too-familiar position for progressives, one that winds back through all of the postwar Democratic administrations of my adulthood. We wanted Lyndon Johnson to push harder for civil rights and anti-poverty and not ruin it all in Vietnam. We were appalled at Jimmy Carter's attacks on government, his failure to use his large Democratic majority in Congress to press for progressive legislation, his refusal to lift a finger on behalf of labor law reform. The memories of Bill Clinton are sufficiently recent that we need little reminder of the needless tilt to the right on economic issues from NAFTA to welfare reform to financial deregulation.

What makes this situation different is, first, our gratitude on so many fronts combined with the very high stakes of the financial rescue. Barack Obama is an exemplary leader in so many ways, the leader we've been waiting for. His commitment to restore constitutional government is no small achievement. Those fighting for anti-poverty efforts and children's initiatives have never seen increases in federal resources comparable to the present ones. His foreign policy initiatives, from his reaching out to Iran to his efforts on behalf of nuclear non-proliferation are a breath of fresh air. And speaking of which, Obama seems serious about reducing the carbon footprint.

But all of this promise could come to naught if the economy remains mired in recession. And despite large scale stimulus spending, the economy will remain stuck in first gear until the banking system is revived.

The economists whom I most respect, such as Joseph Stiglitz, Jeff Sachs, Simon Johnson, and Paul Krugman, all have grave doubts about whether the Geithner-Summers plan can work. The more details are revealed, the more curious it looks. If the plan did succeed in bringing zombie banks back to life, we might hold our noses at the fact that hedge funds and private equity companies were profiting, while taxpayers and the Federal Reserve bore the risk.

The problem, however, is that the plan is not just outrageous in terms of promoting a form of gambling with public subsidy, in which taxpayers bear most of the downside risk while the speculators get most of the upside gain. Nor is it problematic just because of the recently exposed conflicts of interest, which range from the large speaking fees given Larry Summers by some of the very firms that benefit from the bailout to the fact that the Geithner approach was literally designed not by the government but by Goldman Sachs, Pimco, and others that will directly benefit.

The more serious problem is that the plan is conceptually flawed. It presumes that it's possible to create a market that will bid up the value of securities that have lost most of their worth because the mortgages on which they were based will never be repaid at anything like their par value. Banks can play all kinds of games to try to increase the prices at which these securities trade. But unless the taxpayers and the Fed make up virtually the entire loss in banks' balance sheets, the trading games will not serve to recapitalize the banks.

And if a total taxpayer bailout is the real plan, it would be far better to do it straightforwardly with something like a Reconstruction Finance Corporation. A new RFC would conduct real audits of troubled banks (not "stress tests), determine how much capital they needed, and decide what combination of taxpayer and Federal Reserve assistance, coupled with sacrifices from bondholders and shareholders, would make up the gap.

The administration's approach to the auto rescue suggests the more robust strategy needed for the banks: take a hard look at the company's books; fire incumbent management; make all stakeholders take some sacrifices; and involve government directly in the design of a leaner and more efficient successor firm. But nothing of the sort is being done with the banks.

See more stories tagged with: bank, obama, bailout, larry summers, geithner, tarp

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His recent book is "Obama's Challenge: America's Economic Crisis and the Power of a Transformative Presidency."

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